The European Commission sent a letter of formal notice to Hungary on February 7, launching an infringement procedure over the country's Sovereignty Protection Act. The legislation violates many EU laws and infringes several fundamental rights, the EU executive said. Hungarian assets weakened on the news with stocks and the forint trading lower.

The law contains provisions and amendments to already existing legislation "that prohibit candidates, political parties and associations participating in elections from using foreign funding to influence or attempt to influence the will of voters for the elections in question, and to punish under criminal law the use of foreign funding in the context of elections", the Commission said.

The statement noted that the law established the Sovereignty Protection Office, "tasked with investigating specific activities carried out in the interest of another state or a foreign body, organisation or natural person, if they are likely to violate or jeopardise the sovereignty of Hungary; and organisations whose activities using foreign funding may influence the outcome of elections or the will of voters".

Hungarian lawmakers approved the controversial act designed to protect national sovereignty and interests from external threats in late December. It gives the government new powers to investigate and prosecute activities deemed to be against Hungary's interests, but critics said it aims to intimidate and silence critics of the government.

The acceptance of foreign funds for political purposes, or the attempt to conceal them, would be punishable by up to three years in prison.

Fidesz is using the legislation to cut off opposition from foreign financing sources, be it micro-donations from private individuals or other larger funding from foreign donors ahead of the 2024 local government and EP elections.

Tamas Lanczi, the head of the new office working from February 1, has tried to allay concerns, noting that his organisation was not an authority but an office with "primarily analytic and fact-finding tasks". It would not mount investigations or issue sanctions, he added.

After a "thorough assessment", the EC said it found the law to violate several EU laws, "among others the democratic values of the Union; the principle of democracy and the electoral rights of EU citizens; several fundamental rights enshrined in the EU Charter of Fundamental Rights, such as the right to respect for private and family life, the right to protection of personal data, the freedom of expression and information, the freedom of association, the electoral rights of EU citizens, the right to an effective remedy and a fair trial, the privilege against self-incrimination and the legal professional privilege; the requirements of EU law relating to data protection and several rules applicable to the internal market."

Hungary has two months to reply to the letter of formal notice. Should it not address the issues listed in the letter, the EC may step up the procedure by sending a reasoned opinion.

The European Commission launched the infringement procedure less than six weeks after the ratification of the law and a week after the Sovereignty Protection Office. This could likely escalate the conflict between Budapest and Brussels at a time when Hungary is trying to unfreeze billions of euros and eventually could trigger a new conditionality mechanism.

This latest anti-EU legislation could be featured in the annual rule of law report due in July.

The European Commission is under pressure from the European Parliament to take a tougher stance against Hungary after the recent resolution to investigate its decision to unlock €10.2bn of EU funds to the country in December 2023.

There are calls in Brussels to punish Hungary and its strongman Viktor Orban taking the EU hostage by blocking constantly key EU decisions.

A confidential proposal circulating in Brussels called for shutting off all EU funding to Budapest to spook investors and sabotage Hungary's fragile economy. Although the report by the Financial Times published on January 29 was downplayed by an EU official, who called it a background note on the current status of the Hungarian economy, the suggestion that EU leaders were even contemplating such a step raised eyebrows in Brussels.

Orban’s ruling Fidesz party will use the latest news to stir up negative sentiment against the EU to mobilise voters in the June EP and local government elections, claiming the EU is attacking Hungary’s sovereignty.

Hungarian stocks fell 1% on the news, and the forint traded 0.7% weaker against the euro on Wednesday afternoon.